Long-Term Fiscal External Panel

Transcription

1 Long-Term Fiscal External Panel Summary: Session One Fiscal Framework and Projections 30 August 2012 (9:30am-3:30pm), Victoria Business School, Level 12 Rutherford House The first session of the Long-Term Fiscal External Panel, which was established to challenge and test the Treasury s approach to its next Long-Term Fiscal Statement, was held at the Victoria Business School on Thursday 30 August. The session discussed the requirements for fiscal sustainability and a framework to evaluate the sustainability of government fiscal policy, initial projections from Treasury s Long-Term Fiscal Model, the demographic and economic assumptions used in the model, an assessment of the impact of demographic change on taxation revenue, and factors that may impact on New Zealand s economic and fiscal positions in the future. This summary highlights the key points to emerge from the session. Copies of the research papers presented at the session accompany this summary. Please note that the research papers presented at the External Panel session are draft works-in-progress. The presentation and analysis of some issues addressed in these drafts may be refined, amended or strengthened in the 2013 Statement on the Long-Term Fiscal Position. HIGHLIGHTS Maintaining low government debt and building a stronger and suitably liquid Crown balance sheet are two critical factors that will determine New Zealand s success in dealing with economic and other shocks in the decades ahead. The Treasury needs to further address the suitability of its working assumption for net debt to be anchored at around 20% of GDP on average over the next 50 years, including in light of the Crown s balance sheet and the levels of private sector debt. The change in New Zealand s population structure is a permanent phenomenon resulting in much higher proportions of people in the older age brackets. This change is the result of people living longer and of lower fertility compared to the past. This change is expected to have a significant impact on the level of government expenditure, the budget balance and the level of public debt if policy settings remain the same. Long-term projections using the Treasury model suggest the impact will be particularly marked for spending on New Zealand Superannuation and health. The projections are sensitive to demographic assumptions. Statistics New Zealand s latest labour force projections incorporate higher labour force participation rates than in the past. The Treasury needs to address whether the revised assumptions for female labour force participation remain too low and whether alternative scenarios should be modelled. Treasury also needs to be explicit in acknowledging risks around its migration assumptions. Treasury is proposing to take a new approach to the next Long-Term Fiscal Statement with a much stronger focus on projected changes to the Crown s primary balance (operating balance excluding debt-servicing costs) and the potential policy responses required to maintain a stable and sustainable debt level over the long term. Page 1

2 Treasury is also proposing to focus more strongly on quantifying the potential implications of delay in securing a prudent level of public debt. Treasury needs to further investigate the economic and distributional implications of delays in adjusting government policies to address the future impact of population change and rising pressures on public spending. Updated age-based tax projections for personal income tax and GST are not materially different from previously published assumptions for tax revenue over the next 50 years. Treasury needs to further investigate whether there may be higher growth in the level of future tax revenue derived from investment income. The Treasury projections incorporate a labour productivity growth assumption of 1.5% per annum over the next 50 years. While there is some uncertainty, over the medium term New Zealand s labour productivity has grown by up to 1.5% (depending on the data used), including during times in which New Zealand experienced a variety of economic, financial market and natural environment shocks. Potential upside and downside risks include those arising out of technological advances, climate change and potential responses to income inequality. PRESENTATION THEMES What is Fiscal Sustainability and why is it important? Fiscal sustainability refers to the health of governments finances over time. The sustainability of Crown accounts refers to the extent to which future governments can realistically expect to maintain current spending programmes without sooner or later needing to either raise taxes or cut public services in order to avoid incurring excessive levels of debt. Maintaining a sustainable fiscal position enhances the ability of governments to respond to adverse shocks, to dampen volatility in Crown expenditure and tax rates and to support investor confidence in New Zealand critical ingredients for determining New Zealand s economic and social conditions now and in the future. The Public Finance Act (1989) requires governments to manage total Crown debt at prudent levels. While the working definition of prudent is the responsibility of each government, the legal framework requires governments-of-the-day to ensure that the fiscal position they pass on to subsequent governments is not unduly burdensome. In this sense, there is an intergenerational aspect to New Zealand s legal framework because governments are required to explain how their stewardship in the present is consistent with protecting the financial position of the governments of future generations. New Zealand governments significantly reduced Crown debt levels during the 1990s and until the start of the Global Financial Crisis. Subsequently, and as consequence of the Crisis, earthquakes and the domestic economic downturn, public debt has increased although it remains below the levels of many developed economies and below levels considered likely to have significant adverse effects on the economy. Figure 1 below shows government debt levels over the past 25 years and the debt targets used by successive governments. Page 2

3 Figure 1 - Government debt ratios and debt objectives, It is outside the scope of Long-Term Fiscal Statements to make policy recommendations about suitable debt levels and fiscal policy adjustments. For modelling purposes, however, the Treasury examines alternative scenarios which constrain net government debt to 20% of GDP on average over time while also examining the sensitivity of fiscal projections to lower or higher net debt targets of between zero and 40% of GDP. The Treasury proposes to continue to use a 20% net debt target as a proxy for prudent debt levels in its 2013 Statement. It will need to explain why it assesses this to be a realistic and credible anchor over the next 50 years, given the historic propensity for the Crown s financial position to be adversely affected by various economic and financial shocks, natural disasters, and the history of a relatively high level of private sector debt. Demographic projections The age structure of New Zealand s population has been on an ageing trend for over a century. People are living longer and having fewer children and, as a result, the median age has been consistently rising since the 1960s. In 2010 there were 5.1 people aged to every person aged 65-plus, but by 2060 this ratio is projected to fall to 2.3. This is a trend being experienced across the developed world and reflects the same structural dynamics of falling fertility rates and rising mortality rates experienced in other parts of the world. While the ageing of the baby boomer generation is presently accentuating this change, these demographic changes are likely to be permanent and the ageing process is projected to continue after the baby boomer generation has died. Page 3

4 Figure 2 - New Zealand population age structure, 1960, 2010 and 2060 Although demographers are confident about the ongoing ageing of our population, there is uncertainty around individual aspects of the demographic projections and the particular assumptions used in the Treasury model projections. To better communicate this uncertainty, Statistics New Zealand this year published probabilistic ranges for demographic outcomes instead of the high, median and low tracks projected previously. The adoption of stochastic projections helps to convey a better sense of the degree of uncertainty around a median projection and its components. Statistics New Zealand s demographic projections provide the basis of Treasury s long-term fiscal projections. In its 2013 Statement, the Treasury will discuss the risks around assumptions for female labour force participation in particular and will also take care to be explicit in acknowledging risks around migration assumptions. For a summary table of assumptions, see Annex 1. The long-term fiscal outlook These demographic trends, along with factors such as the availability of new technologies and rising public expectations for services, can be expected to create on-going pressure for government spending programmes and challenges for governments finances over the coming decades. Table 2 shows the Treasury s current preliminary projections for how the Crown s budget might look every 10 years between now and 2060 in the event of no policy actions being taken to address these projected spending pressures. The table is notable for a number of points: The strong growth of health and NZS expenditure, relative to nominal GDP. These two expense types in particular are driven up by the faster growth of the 65 and above age group relative to the labour force. The rapidly rising debt financing costs. It is these in particular that fuel the growth of debt via an interdependence with the debt stock. In other words, as borrowing grows to cover deficits the annual interest costs on debt grow, which in turn adds to the debt stock that is generating them. At any year shown, it is important to realise that closing the operating balance gap only stabilises net debt at the level it has already reached. Reducing debt to a level of 20% of GDP, say, becomes a much harder task over time and involves the need to produce greater levels of budget surpluses the longer the cost pressures are allowed to continue unaddressed. Under these projections, governments would begin running budget deficits from 2026 onwards. As a consequence of these budget deficits and growing interest cost payments on public debt, the level of public debt will rise and potentially to critical levels. Page 4

5 Table 2 Break-Down of Projected Government Expenses and Revenue, (% of nominal GDP) Health Superannuation (NZS) Education Other Op. Allow. Covered Non-NZS Welfare Debt-financing costs (DFC) Total Expenses Revenue (majority tax) Gap to Balance Budget Gap excluding DFC Core Crown Net Debt *These projections are based on the Treasury s preliminary baseline assumptions that they will be testing throughout the Panel process. The point of Table 2 is not to suggest that these expenditure and revenue tracks are optimal in any way, or that these will be the outcomes. There is no reason to assume that governments over the next 50 years will be any less fiscally prudent than those over the last 30 years; rather it is to highlight the need for policy adjustments to ensure that budget balances and the level of public debt remain at prudent levels. The Treasury proposes to focus much more attention in the 2013 Statement on policy options for governments that address these fiscal challenges and on weighing up the pros and cons of alternative policy options to maintain a prudent level of public debt. The options will focus on possible changes to spending programmes (such as superannuation, heath, etc) and taxation. They will also focus on the timing of adjustments. Attention will also be given to assessing the trade-offs between policy options. This will involve assessment of the economic growth effects, distributional effects, the effects on economic and social vulnerability, etc. of options for addressing fiscal sustainability. The timing of fiscal adjustment The Treasury s current projections (which are still preliminary) indicate that to stabilise net Crown debt at 20% of GDP will require future governments to run small budget surpluses on average over time. The Treasury has run some projections that indicate: If fiscal adjustment starts in 2015 (building on the current programme of fiscal consolidation) then governments would need to run budget surpluses equal to 1.9% of GDP a year for a decade to stabilise net debt at 20% of GDP; A delay to this adjustment until 2020 would require average surpluses thereafter of 2.2% of GDP to reach the debt target within a decade; and Delaying adjustment until 2030 would require average annual surpluses thereafter of 2.3% of GDP to reach the debt target within a decade. To put these figures in context, during the decade from when there was strong revenue growth, governments ran average budget surpluses of 2% of GDP. Delaying fiscal adjustment, in addition to requiring a greater degree of eventual fiscal adjustment, also exposes the wider economy to increased vulnerabilities and risks. Page 5

6 The impact of population ageing on income and consumption patterns and tax revenue In addition to providing analysis of the projected effects of population ageing on different Crown expenditure areas, the 2013 Statement will provide assessment of the implications that demographic change poses for the Crown s taxation revenues, and the components of taxation, in the years ahead. Population ageing might be expected to have an impact on income tax and GST revenue due to the variation in income and consumption over life cycles, and through the impacts of population ageing on labour force participation rates, especially among women. However, recent Treasury research suggests that while we might expect some compositional changes within the tax base, projections for aggregate income tax and GST revenue taking into account population ageing are not expected to make a material difference from the aggregate level of taxation if, as was assumed in the past, taxation is maintained at some constant ratio of GDP. The research suggested that while ageing was likely to reduce aggregate income tax revenue, increased revenue from the projected effects on participation rates could more than offset this. It should be noted that these estimates are highly sensitive to changes in the overall rate of change in wages, which is a major determinant of tax revenue growth, along with assumptions around indexation of income tax thresholds relative to wage inflation. The economic context While there have been big changes in New Zealand s economic performance across recent decades, New Zealand has averaged medium-term labour productivity growth of up to 1.5% per annum across recent business cycles. Some estimates suggest that technological advancement, together with the rising significance of Pacific Rim economies in global economic activity, may mean that New Zealand s growth potential could improve. However, there remains uncertainty over the future trend growth of productivity, and there are reasonable grounds for arguing that our growth rate may be lower in the future. As a result, the Treasury proposes to continue to assume the annual rate of 1.5% growth in its 2013 Statement. Framework for policy analysis The Treasury s current preliminary projections suggest current fiscal policy settings are not likely to be sustainable in the long term. The next External Panel session will discuss a framework for analysing possible policy reform options to meet the fiscal challenge arising out of population ageing. The diagram below shows how the Treasury s Living Standards Framework could be applied to assessing these choices and for weighing up the trade-offs involved with each fiscal policy option. Page 6

7 DISCUSSION Following the authors presentations of their papers, Panel members gave their feedback. Some of the key issues that were raised included: The suitability of a 20% net debt target The Panel questioned whether 20% net government debt as a proportion of GDP was a sufficiently low sustainable debt target for New Zealand. There is no simple rule for how to set such a target, but several issues are relevant. Factors such as the level of indebtedness of the private sector, the strength and composition of the government s balance sheet, and the denomination and ownership profile of sovereign debt all affect the government s ability to rely on debt to provide a fiscal buffer to accommodate adverse shocks. The financial position of the private sector is particularly important to consider due to the speed with which economic circumstances in the private sector can flow through to the government s finances. Ireland was cited as an example where, during the Global Financial Crisis, general government net debt rose dramatically from 11% of GDP in 2007 to over 100% in 2012, due in part to the structure of the Irish banking sector and the role the government played in supporting the private banking sector. The Panel felt that given New Zealand s high levels of international indebtedness, the concentration of this debt in the private sector, and its propensity to experience large commodity price and other shocks, an average net debt target of lower than 20% across the cycle might be more appropriate. The Panel also noted that any target should be communicated as an average level to be maintained across the business cycle rather than viewed as a floor. The Treasury s Long-Term Page 7

8 Fiscal Model abstracts from business cycles and projects economic variables growing at stable growth rates. The Panel suggested that communication around this risked underplaying New Zealand s historically high propensity for shocks. This propensity meant that to ensure sustainability of any debt target through the cycle, governments would need to manage debt to levels significantly lower than it has traditionally even in good times. The Panel also questioned whether the projections for expenditure on non-nzs welfare are sustainable, particularly with regard to the assumption of continuing the current policy of indexing welfare payments to Consumer Price Index inflation. This assumption is the main driver of the downward trend in non-nzs welfare as a proportion of GDP in the preliminary baseline projections. The conservativeness of demographic projections While the Panel was comfortable with the presentation of the demographic trends and the overall implication of these for New Zealand s population structure, some questioned whether the central projections for a number of specific assumptions were appropriate. The female labour-force participation rate was one area where it was noted that the central projection might be underestimating future changes. The central projection assumes a relatively constant female participation rate across the projection period, reflecting a view that the growth in female participation experienced recently is unlikely to be sustained into the future. While it was noted that the wide upper- and lower-bounds for the stochastic projections reflected the degree of uncertainty around this projection, it was suggested that the Treasury should test the sensitivity of their fiscal projections to changes in this assumption. Net migration was another area where it was suggested that the central projections might be too low. The level of net migration has fluctuated markedly over the past 40 years and is particularly hard to project. However, it can play a strong role in the level and age-composition of population growth, with net migration contributing roughly half of New Zealand s population growth between 2001 and The Panel wondered whether there were any factors in the coming decades, such as the return of the Kiwi diaspora or a rise in New Zealand s attractiveness to skilled foreigners, which might raise the level of migration above current projections. Future changes around Maori and Pacific Islander demographics were also acknowledged as areas that may not be fully captured in the headline population projections. A number of factors particularly relevant for Maori and Pacific Island communities were noted as having a greater degree of uncertainty. For example, possible future societal changes affecting the prevalence of smoking could be particularly beneficial to the mortality rates of these communities. Also, longevity improvements could be particularly beneficial for female labour force participation in these communities where elderly tend to play a greater role in raising children. The impact on income inequality The Panel raised the importance of considering implications of the projected demographic, economic, and fiscal changes for inequality within our society. Incomes in New Zealand, and in other developed countries, have been growing increasingly unequal over recent history. When projecting societal changes such as these it is important to assess how they may lessen or exacerbate income distribution. What do the long-term economic growth projections imply for income inequality over the next 50 years? What implications would different levels of debt targeting, and the resulting different levels of fiscal adjustment, have on different income groups? Also, if this trend toward greater inequality continues, what are the reverse implications Page 8

9 for long-term economic growth, the fiscal position and the individual areas of government expenditure? Issues around equality and equity will be addressed in subsequent Panel sessions. Projections of investment income tax revenue The Panel noted that while Treasury estimates suggest little aggregate impact of population ageing on the sum of income and consumption tax revenue, the projected path of future tax revenue from investment income should be investigated. In previous Statements, projections of investment income tax have been largely incorporated into income tax revenue and not individually looked at. However, with a larger proportion of the population entering the older age groups age groups with typically higher levels of wealth and savings it is likely that this tax base could grow significantly over coming decades, resulting in higher tax revenue. This will likely be heightened with Kiwi Saver as the nation s pool of savings in the scheme grows over time. Treasury will undertake some work to project investment income tax in time for the third External Panel session. Page 9

10 ANNEX 1 - SUMMARY OF KEY ASSUMPTIONS Demography 2009 Now Base case Series (base) 50th percentile 2011(base) Fertility Period life expectancy Net migration Falls to 1.9 babies per woman Rises to 85.6 years (M), 88.7 years (F) in 2061 Reaches 10,000 shortly into the projection The same but takes a decade longer to reach 1.9 Rises to 88.1 years (M), 90.5 years (F) in 2061 Reaches 12,000 shortly into the projection Economy 2009 Now Productivity 1.5% from % from 2020 growth Participation Series 5 medium 2010(base) 50th percentile 2006(base) Overall part rate in 2061: 63% Overall part rate in 2061: 65% Average weekly hours worked 35 hours 33.2 hours Inflation rate 2% mid-band 2% mid-band Long bond rate Holding at 6% through projection Rising to 5.5% in the 2020s rising to 6% from 2030s Fiscal 2009 Now Revenue (largely tax) Long term ratio 28% of GDP Long term ratio 29% of GDP Expenditure - Public services (growth set by operating allowances in forecast period) Health Education Public sector productivity of 0.3% a year Real growth of 1.2% (80% of wage growth - 1.5% - passes through) Real per person growth rates 0.8% Price adjusted growth 1.7% Static cost curves Real per person growth rates 0.8% Price adjusted growth 1.7% Public sector productivity of 0.3% a year unchanged Real growth of 1.2% unchanged (80% of wage growth - 1.5% - passes through) Real per person growth increased to 1.5% Price adjusted growth is now 2.4% Healthy ageing assumed (curves move out with life expectancy gains) Real per person growth rates 1% Price adjusted growth 1.9% Others Real per person growth rates 0.8% Real per person growth rates 0.8% Expenditure - Transfers (growth is demand-driven) Superannuation (NZS) UB, DPB, IB, SB, and other welfare Indexed by nominal wage growth Indexed by inflation Expenditure - Debt-financing costs End of current fiscal strategy period First year of projections End of year debt*new year's bond rate After 5 years (2014) Indexed by nominal wage growth Indexed by inflation End of year debt*new year's bond rate After 3 years (2015) only for public services; Rest follow five years of forecast Page 10